The Soon To Erupt Euro Experiment

By Gordon T Long

THE EURO EXPERIMENT

12-08-16-macro-regional-eu-eu_experiment-1It was always blatantly clear that an EU monetary union would inevitably require a political union to centralize decisions about tax and public spending. Without this occurring it was a misconceived and terrible blunder (that some of us argued it was when it was initially constructed) but it is turning out to be even worse than we originally perceived because of its underpinning Euro currency.

We are now witnessing that the EU experiment has become so damaging and divisive that public opinion will now never tolerate a political union. So not only was the cart put before the horse, but the horse will not now contemplate even following the cart at a distance!

One of the reasons is that it has made countries, like Italy, Spain, Portugal and Greece, poorer while others got richer. Forcing many countries to have the same interest rates and exchange rate was foreseeable always going to be a problem, as it would lead to some countries having booms followed by big busts, as has happened in Ireland, Portugal and Spain.

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It has lead to per capita income of Italians for example being lower now than in 2000, which is why they are – not surprisingly – getting increasingly restive, while in the meantime, the German economy has kept on growing, and the average German is about 20 per cent better off over the same period. The euro is a cheaper currency than the Germany Mark would have been if it still had the deutschmark, while it is more expensive than Italy would have if it still used the Lira. Germans therefore keep exporting easily and running up a surplus, while the Italians struggle and go deeper in to debt.

Furthermore, the freedom of movement of capital in Europe probably makes this worse – why would you put your euros in an Italian bank when you can invest them in Germany? Membership of the euro has thus put the Italians (and what we once politically incorrectly referred to as the PIGS) on a permanent path to being poorer.

Simply stated, the euro zone doesn’t have the fiscal or banking unions it needs to make monetary union work, and it’s not close to changing that. In the meantime, the euro’s continuing flaws continue to suck countries into crisis. And their politics get radicalized out of misunderstood populist frustrations.

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A FAILED CURRENCY

The Atlantic pointed out the flaws the Euro was facing back in 2013 shortly after the EU Banking Crisis, which has been steadily deteriorating since as result:

1. Too Tight Money

The euro zone isn’t what economists call an “optimal currency area”. In other words, it was a bad idea. Its different members are different enough that they should have different monetary policies. But they don’t. They have the ECB setting a single policy for all 17 of them. That’s a particular problem for southern Europe now, because their wages are uncompetitively high relative to northern European ones, and the ECB isn’t helping them out.

There are two ways to fix this intra-euro competitiveness gap. Either northern European wages rise faster than normal while southern wages stay flat, or northern European wages grow normally while southern European wages fall. It’s the difference between a bit more inflation or not — in other words, between looser ECB policy or the status quo. Now, it might not sound like it really matters which option they choose, but it very much does. Falling wages make it harder to pay back debts that don’t fall, setting off a vicious circle into economic oblivion.

2. Too Tight Budgets

Austerity has been a complete disaster. It’s actually increased debt burdens across southern Europe, because it’s reduced growth more than it’s reduced borrowing costs. And now northern Europe is getting in on the act. France (which is really somewhere in between “southern” and “northern”) just missed its deficit target, and is set to slash more; the Netherlands has put through contentious tax hikes and spending cuts, even as its economy has shrunk; and even Germany is contemplating new budget-saving measures. In other words, the euro has become an austerity suicide pact.

3. Too Little Trade

Excluding Germany, just over half of all euro trade is with each other. But with bad policy pushing southern Europe into depression and northern Europe towards recession, euro zone countries can’t afford to buy as much stuff from each other. That adds a degree of difficulty to recovery for southern European countries that need to export their way out of trouble. As you can see in the chart to the right from Eurostat, intra-euro zone trade has stagnated the past few years (and headed lower since) after rebounding from its post-crash depths. The euro zone’s weak links are dragging the rest down — but only because the rest refuse (or can’t) to pull the weak ones up.

4. Too Much Financial Interconnection

Other country’s problems can quickly become your own if your banks own their bonds. Especially if your banks are bigger than your economy. That’s the lesson Cyprus learned the very hard way  after its banks loaded up on Greek debt in 2010, only to get wiped out a year later. The Financial Times has a great infographic (that you should play around with) on which country’s banks are exposed to which other country’s debt across the euro zone. As you can see below, any kind of Italian restructuring would be tremendously bad for French banks.

THE ERUPTION HAS BEEN BUILDING

The mood in the EU has been steadily changing since the initial “Enactment Era” as we then entered the “Expansion Era”, then the “Bailout Era” and now appears to be inevitably heading towards the “Depression Era”!

Figure 2: Eras of European Mood

THE ERUPTION OF EXPLODING POPULISM

This mood shift which I recently explored in a video with Charles Hugh Smith illustrated that Political Polarization, Lack of Cooperation, Rebellion against Political Correctness are all presently manifesting themselves into a rejection of the status quo, “the system” and those trusted with its maintenance.

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The rapid emergence of new anti-establishment populist parties skeptical of the European integration are all strong indicators of the failure of the Euro Experiment which we cautioned about years ago.

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